Is it time to bring an investor into your business?
Read time: 5 minutes
It’s a hard choice faced by many entrepreneurs: Should I give up a piece of my company in exchange for an investment to accelerate its growth?
Your decision will depend on what kind of a business you are running and your ambitions for it. It will also depend on your prospects for success—will an investor want to take a risk on you?
Investors want to see a path to strong growth that will allow them to earn a substantial return on their capital, says Jean-Philippe Pépin, BDC Vice President and National Leader, Tech Industry.
“Investors are going to get a return by raising the valuation of the company and bringing in more money, either through new investments or the sale of the company,” says Pépin, who helps oversee a portfolio of over 1, 200 tech clients. “Among other factors, the valuation is significantly tied to your growth rate.”
Even in a traditional bricks-and-mortar business, investors will want to see a good growth rate and path to profitability that will lead to dividends for them and increase the value of the business over time.
As an entrepreneur, there are a lot of financial and non-financial factors to weigh when considering an investment versus other financing options.
Pros and cons of debt and equity
- Can fuel rapid growth and scale up
- Patient capital that can fund early product development and sales
- No negative impact on cash flow
- Access to network and expertise to help growth
- No ownership dilution
- No interference in day-to-day management
- Potentially lower cost than equity investment
- Interest payments are tax deductible
- Short and long term options
- Ownership dilution
- New partners may want a say in decisions
- Higher cost than debt
- Repayment terms can interfere with rapid growth
- Often requires collateral
- Typically requires additional reporting and governance. (This can also be seen as a pro.)
More than money: Good investors give access to resources
A key advantage of partnering with an investor is the experience, expertise and connections they can offer your company, Pépin says. “They can bring you domain expertise and be ready and willing to open doors for you to help you grow faster.”
Investors also tend to be relatively patient, committed and flexible with the use of funds and encourage maximizing returns rather than meeting a predetermined repayment schedule. Although institutional funds typically come into an investment with a plan for when and how they want to exit.
The upside is you get more experienced people around your board or management table; the downside is you’ve got a new boss.
The flipside is that you have to sell a percentage of your ownership and future growth in its value. As well, investors become your partners in the business and will generally provide input on key management decisions.
“The upside is you get more experienced people around your board or management table; the downside is you’ve got a new boss,” Pépin says. “Some would argue that that kind of governance and accountability is really helpful, but it’s not for everyone.”
That’s why it’s important to carefully consider both the valuation that investors are assigning to your business and whether they will be good business partners in terms of the expertise they offer, their patience with your business plan and how well you will work together.
Debt financing can serve as an alternative to equity
An alternative to seeking an investor is to “bootstrap” the company—using the cash flow the business generates to fund its growth. This route may not be a viable option for businesses that need large upfront investments for product development, marketing, staffing and other expenses.
Another possibility is to borrow money. Pépin says a business loan can be a good option for companies that are generating a steady stream of revenue or have assets on which to secure a loan.
With debt financing, you don’t have to give up ownership and lenders don’t typically get involved in management decisions as long as you are repaying your loan and meeting your agreed milestones.
Here again, you should proceed with caution, evaluating not only the interest rate being offered, but also the terms and conditions of the loan and what kind of relationship you will have with the lender, Pépin says. “Set the right expectations for one another up front.”
Mixing debt and equity can be a good option
One option is to use both debt and equity financing. For example, you could use loans to help finance operations between equity financing rounds. Or, you could use loans to fuel your growth and then take on an investor when the company’s equity can be sold at a higher valuation.
Lenders don't want you to do anything that would risk repayments and investors don’t want you to do anything that would limit growth.
However, McCartney warns investors may shy away from your company if you are carrying too much debt because of concerns you may end up using their investment to pay off loans or sacrifice growth to repay the money.
“Lenders don’t want you to do anything that would risk repayments and investors don’t want you to do anything that would limit growth.”
Consider different scenarios
When considering whether to partner with an investor or making another financing transaction, Pépin recommends you identify “what you must have, what you want to have and what you’re willing to trade.”
Your goal is to find the optimal mix both in terms of type and amount of financing to fuel your company’s growth throughout its journey and ensure you reap the fruits of your hard work.
“Test different scenarios to understand the real cost difference—both financial and non-financial—between funding options now and over your business’s life cycle.”